On defaulters, RBI prioritises public interest

Source– The post is based on the article “On defaulters, RBI prioritises public interest” published in “The Indian Express” on 20th June 2023.

Syllabus: GS3- Indian economy and mobilisation of resources

Relevance- Issues related to banking system

News- On June 8, the Reserve Bank of India set out a framework for bank settlements with defaulters.

Why should banks settle with defaulters?

When there is a default, the primary objective of a bank is to recover as much of the loan as possible. Various options might be available to the bank.

The bank decides the best strategy based purely on commercial judgement.

Why is it wrong to think that the RBI has permitted something unusual?

One-time settlements are part and parcel of the business of banking. The RBI has simply given a formal regulatory structure to a standard banking practice.

Some of these settlements can indeed be with wilful and fraudulent defaulters. When trying to recover a loan, a bank should not make any distinction between wilful, and fraudulent default. It is up to the bank to decide whether a settlement is a better and quicker option. The sole motivation behind such a decision should be to maximise recovery.

The RBI circular makes it clear that banks can file cases against fraudulent or wilful defaulters.

As per circular, banks will undertake settlements “without prejudice to the criminal proceeding underway against such debtors”. In other words, the circular does not condone any crime.

What are some valid concerns raised by this circular?

Government control over public sector banks– The settlement process might be misused to favour politically connected defaulters at the cost of the banks’ commercial interests. It is the responsibility of RBI to allow commercially prudent decisions and prevent politically motivated ones.

There is ample evidence that private sector banks have been settling with wilful defaulters. So, questions arise about the need for this circular.

The answer possibly lies in the fact that two-thirds of the Indian banking system is owned by the government. The RBI circular gives these banks regulatory cover for settlement-related decisions.

Therefore, the circular merely levels the playing field. But the need for such a circular underscores the distortions that the Indian banking system suffers from government ownership of banks.

Regulatory governance– A year ago, the RBI recommended that the RBI place all draft instructions on its website for stakeholder comments. Exceptions should be made only in special circumstances.

There do not appear to have been any special circumstances surrounding the RBI circular related to settlement. There were no issues related to financial stability, or fiduciary duty, or confidentiality.

At the same time, the circular is of great public interest since it applies to entities against whom criminal proceedings are underway.

Hence, the draft circular should have been placed on the RBI’s website for public consultation along with a discussion paper clearly explaining its rationale.